What Is a Bullet Repayment?
A bullet repayment is a lump sum payment made for the entirety of an outstanding loan amount, usually at maturity. It can also be a single payment of principal on a bond.
Loans with bullet repayments are also referred to as balloon loans, and they're commonly used in mortgage and business loans to reduce monthly payments during the term of the loans.
- Loans with bullet repayments are commonly used to reduce monthly payments to interest-only payments during the term of the loans, but a large, final payment of principal eventually comes due.
- Balloon lenders sometimes offer borrowers an option to convert loans to traditional amortizing loans rather than face a huge one-time payment.
- Bullet repayments have also been integrated with fixed-income based exchange-traded-funds (ETFs), giving them bond-like predictability for investors.
How Does a Bullet Repayment Work?
Bullet repayments and balloon loans are not normally amortized over the duration of the loan. The final balloon payment is often the only principal payment made, but the balance might occasionally be amortized through other smaller, incremental payments before the balloon payment comes due. The final payment is nonetheless significantly larger than the others, and it retires the loan.
The deferral of principal payments until the loan matures results in lower monthly payments during the life of the loan, because these payments usually represent only interest. But this presents a significant risk to borrowers who aren't prepared to make the large lump sum payment or who don't have other arrangements in place to deal with the bullet repayment.
Bullet repayments have also been integrated with fixed-income based exchange-traded-funds (ETFs), giving them bond-like predictability for investors.
A bullet repayment due at a loan’s maturity often necessitates advanced planning to have a refinancing facility in place, unless borrowers have the cash to pay off the large lump sum.
Bullet Repayment vs. Amortization
The difference between interest-only payments on a loan with a bullet repayment and amortizing mortgage payments can be quite significant. For example, the yearly interest would be $9,600 and monthly payments would be $800 on a 15-year interest-only mortgage of $320,000 with a 3% interest rate. That same loan with amortization would have a monthly payment of $2,210.
The monthly payment schedule clearly favors the interest-only loan, but the interest-only borrower faces a bullet repayment of $320,000.
Example of ETF Bullet Payments
The investors assume the role of lenders in ETFs with bullet repayment dates, while the funds act as the borrowers.
Funds with bullet repayments are usually composed of bonds, notes, and fixed-income vehicles with maturities preceding the bullet repayment date. Investors receive regular interest payments on their shares during the term of the fund, and they're repaid the principal from the matured portfolio holdings on the bullet repayment date.
The key benefit of the bullet repayment for investors is the predictability of the return of principal on a specified date, much like the maturity of a bond.
A borrower basically has two options if money is not available to pay a loan in full as the bullet repayment date approaches. The property can be sold, with the proceeds used to pay the loan principal, or the loan can be refinanced, taking out a new loan to cover the bullet repayment.
Under certain circumstances, balloon lenders might offer borrowers the option to convert loans to traditional amortizing loans rather than face a huge one-time payment.